Generation-skipping transfer tax

The U.S. Generation-skipping transfer tax imposes a tax on both outright gifts and transfers in trust to or for the benefit of persons two or more generations younger than the donor, such as grandchildren. The generation-skipping tax will be imposed only if the transfer avoids incurring a gift or estate tax at each generation level.

For example, property is placed in a trust for the donor's child and grandchildren. The income may be distributed among the child and grandchildren in accordance with their needs and the principal of the trust will be distributed outright to the grandchildren following the child's death. If the trust property is not subject to estate tax at the child's death, a generation-skipping tax will be imposed when the child dies.

The first version of the tax (1976)

The first version of the generation-skipping tax was introduced in 1976. That version attempted to impose a generation-skipping tax exactly equal to the estate or gift tax that was avoided. In the above example, the Executor of the child's Will would have had to determine the estate tax, if any, the child's estate owed without regard to the existence of the trust. Then the Trustee of trust would have to use the child's Federal Estate Tax Return as the basis for recomputing the child's estate tax liability as if the trust property had been part of the child's estate.

The version of the tax starting in 1986

That approach posed so many administrative problems that in 1986 Congress repealed the 1976 version and enacted a new generation-skipping transfer tax law.

The current version of the generation-skipping tax no longer attempts to impose a tax equal to the estate or gift tax that was avoided. Instead, the generation-skipping tax is imposed at a flat rate equal to the highest marginal estate and gift bracket applicable at the time of the gift or bequest. That rate is currently 45%.

Each taxpayer currently possesses a $2,000,000 exemption from the generation-skipping tax. Only aggregate gifts and bequests to grandchildren or younger beneficiaries in excess of $2,000,000 ($4,000,000 for a married couple) will be subject to the generation-skipping transfer tax. This exemption is scheduled to increase to $3,500,000 in 2009 and become unlimited in 2010. However, the law that created the increases to the GST Tax Exemption, lowered the tax rate and is scheduled to eliminate the GST tax in 2010 is set to expire in 2011. This means that the GST exemption amount will return to $1,000,000 per individual in 2011 unless Congress makes additional changes.

Advantages of using exemptions from the tax

Many parents who might otherwise leave their entire estates outright to their children use their generation-skipping exemptions to create an exempt generation-skipping trust for their children and grandchildren funded with up to $4,000,000 of cash or property.

Utilizing the generation-skipping tax exemption in this manner offers two important advantages:

*The trust will escape all transfer taxes when the children die and will pass tax-free to the grandchildren.

*The trust may be protected from the claims of creditors and, to some degree, from claims of ex-spouses. Had the trust property been left to the children outright, the property would be subject to such claims.

ee also

*Uniform Gifts to Minors Act

In some states (Wisconsin is one)property acquired by gift or inheritance from a third party, is not subject to division in divorce proceedings and would not be subject to claims by an ex-spouse.